Norway Faces Liquidity Shock in Record Redemption: Nordic Credit

The redemption threatens to trigger an outflow of funds as foreign investors balk at the loss of liquidity, driving up existing debt prices and weakening the krone, according to analysts at Nordea Bank AB and Danske Bank A/S. Photographer: Kristian Helgesen/Bloomberg

Feb. 27 (Bloomberg) -- Norway’s bond haven is about to
become a lot smaller.

The government is preparing to repay a record 66.5 billion
kroner ($11.8 billion) in 6.5 percent bonds maturing May 15,
which is more than the top-rated nation has left to sell of its
planned 70 billion kroner in issuance this year.

The redemption threatens to trigger an outflow of funds as
foreign investors balk at the loss of liquidity, driving up
existing debt prices and weakening the krone, according to
analysts at Nordea Bank AB and Danske Bank A/S. Offshore
investors own almost 60 percent of the maturing bonds, or about
38 billion kroner, Nordea estimates.

“The amount involved means that this flow could have a
substantial market impact,” said Gaute Langeland, chief analyst
at Nordea Markets in Oslo.

Norway, which boasts the biggest budget surplus of any AAA
rated nation and has no net debt, emerged last year as a haven
from the euro area’s debt crisis. Demand for assets perceived as
safe from Europe’s debt crisis returned this week after an
inconclusive election in Italy fueled speculation the nation may
backtrack on austerity measures.

Norway’s 10-year yields slid seven basis points yesterday
and a further four basis points today to 2.40 percent. The yield
had jumped from a low of about 1.61 percent in July last year
and about 2.14 percent at the start of the year. The yield on
Norway’s 2015 note has rallied to about 1.51 percent, down from
a high of 1.78 percent last month.

Cash Repatriation

Norwegian government debt has the lowest credit default
swap spread of any developed nation, according to data compiled
by Bloomberg. Five-year default swaps traded at 19 basis points
today. Default swaps on U.S. debt traded at 43 basis points
yesterday, while it cost 40 basis points to insure against a
German default.

Still, Norwegian bonds have lost 0.7 percent this year
after European Central Bank President Mario Draghi’s July pledge
to do whatever it takes to keep the currency bloc intact. That
contrasts with Norway’s central bank, which has signaled it’s
prepared to raise rates as soon as next month to cool an
expansion even as policy makers in Sweden, the U.S. and the rest
of Europe have pledged extended periods of low borrowing costs.

“We suspect that quite a few international investors will
choose to repatriate their investments,” said Bernt Christian
Brun, chief analyst at Danske Bank in Oslo. A relatively heavy
issuance of Norwegian bonds in recent months has led to
increased yields and widening spreads compared with German
bunds, particularly on longer Norwegian bonds, Brun said.

Krone Weakness

Norway has held three auctions this year, selling a total
of 10 billion kroner in the three separate bond issues. While it
has only one auction scheduled next month, it plans for two
sales in April and three in May, including one which settles on
the day of the record buyback.

“Norges Bank is doing what they can to keep the assets in
krone but we do expect to see some leakage out of the
currency,” Brun said. “We expect to see krone weakness in the
period leading up to the maturity date.”

The central bank will sell 70 billion kroner of long-term
debt this year, it said on Dec. 20. It increased the number of
government bond auctions to 21 from 17 even as the number of
Treasury bill sales drops, it said. The government plans to
borrow 12 billion kroner to 16 billion kroner in the bond market
during the first quarter.

Light Calendar

The auction calendar remains “particularly light in March
and April,” said Langeland. “This may be a blunder as it is
precisely in this period that spreads tend to widen.”

Swap spreads, or the difference between interest rate swaps
and the yield on government debt, tend to widen between 15 basis
points to 20 basis points in the two months to three months
before bond redemptions, he said.

The government said that while it’s flexible, the oil-rich
nation has no special need to cater to investor demands. Norway
is western Europe’s largest crude and gas exporter and has a
$700 billion sovereign wealth fund. The government takes about 4
percent of the fund each year to plug budget deficits.

“We have flexibility generally to adapt to what we think
is the demand,” Sigurd Klakeg, deputy director general at the
Norwegian Finance Ministry, said by phone Jan. 25. He declined
to comment on whether the bank will increase the size of its
issuance before the 6.5 percent bond matures. “It is not
necessary for us because we have flexibility with a fairly
substantial cash reserve,” he said.

Pose Challenges

The strength of the krone may also pose challenges to
investors. The currency on Feb. 13 climbed to a record on an
import-weighted basis, and has since weakened about 2 percent.

The strength may make investors hesitant to reinvest into
comparatively more-expensive debt, Brun said.

Still, in a world still concerned about the depth of
Europe’s crisis, Norwegian bonds are likely to find a home. If
there are enough of them, that is.

“I suspect those international buyers who own the bonds
bought them for defensive positioning, so I can’t see that has
changed,” said Russell Silberston, a fund manager in London at
Investec Asset Management Ltd. “Yields are relatively high,
debt dynamics are the best in the world and the currency is
strong.”